Credit Suisse (NYSE:CS) failed to get itself clear of a lawsuit filed against it by investors in National Century Finance Enterprises alleging that the Swiss bank misled them into the investment despite being in a position to know that the healthcare financial firm was indulging in fraud. [1] After National Century went bankrupt in 2002, it was discovered that the company had siphoned off investor funds worth $3 billion between 1994 and 2002 and Credit Suisse was promptly sued for its role as the underwriter for the firm’s debt offerings over this period. [2] The latest ruling in the lawsuit makes Credit Suisse completely liable for any damages that will be awarded to bondholders – a figure that could work out to be in excess of $2 billion. This represents a potential loss for the second largest Swiss bank in Q3 or Q4 2013 when the final ruling is announced, besides a notable downside to its share value.

Bondholders in National Century managed to corner Credit Suisse in the lawsuit by providing sufficient evidence to support their claims that they were misled into the investment. And to make matters worse, they also pinned the responsibility on the bank by showing how the only factor that influenced their investment decision was the offering-related documents published by Credit Suisse.

It must be mentioned here that the bondholders include several major institutional investors – Lloyds, MetLife (NYSE:MET) and Pimco (an Allianz unit) among others – and the court upheld their allegations in the lawsuit albeit making note of this fact as the bank indeed had access to more information.

The lawsuit is a major source of concern for Credit Suisse which has been under significant pressure from investors and Swiss regulators to improve its capital structure. In fact, the bank has focused so much on this aspect over recent quarters that its overall performance has taken a back-seat to divestment and capital raising activities (see Credit Suisse Reassures Market On Upcoming Earnings With Statement). With the lawsuit posing a very possible $2 billion liability to the bank, a judgement against it will wipe out this value almost overnight.

If Credit Suisse is hit by the $2 billion charge later this year, then the operating income for its investment banking division will be reduced by that amount. This will clearly dent the margins for the business, the impact of which on the bank’s share value can be understood by making changes to the chart above.

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